Is Stella Holdings Berhad (KLSE:STELLA) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Stella Holdings Berhad (KLSE:STELLA) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Stella Holdings Berhad

How Much Debt Does Stella Holdings Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Stella Holdings Berhad had RM8.69m of debt, an increase on RM1.15m, over one year. However, its balance sheet shows it holds RM9.72m in cash, so it actually has RM1.04m net cash.

A Look At Stella Holdings Berhad's Liabilities

According to the last reported balance sheet, Stella Holdings Berhad had liabilities of RM34.6m due within 12 months, and liabilities of RM1.50m due beyond 12 months. On the other hand, it had cash of RM9.72m and RM30.7m worth of receivables due within a year. So it can boast RM4.27m more liquid assets than total liabilities.

This short term liquidity is a sign that Stella Holdings Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Stella Holdings Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Stella Holdings Berhad's saving grace is its low debt levels, because its EBIT has tanked 27% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Stella Holdings Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Stella Holdings Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last two years, Stella Holdings Berhad burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Stella Holdings Berhad has net cash of RM1.04m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Stella Holdings Berhad's balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Stella Holdings Berhad is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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